2. Perfectly Competitive Markets

Question 1

Characteristics of a perfectly competitive market?

Answer 1

1. Consumers and suppliers are price takes
2. Homogenous goods
3. No externality
4. Goods are excludable and rival
5. Full information
6. Free entry and exit

Question 2

What is the cost benefit principle?

Answer 2

States an action should be taken if the marginal benefit is greater than or equal to the marginal cost

Question 3

What is economic surplus?

Answer 3

The difference between the marginal benefit and the marginal cost of taking an action

Question 4

What is the horizontal interpretation of the supply curve?

Answer 4

Indicates how many units the producer Is willing to supply at that price

Question 5

What is the vertical interpretation of the supply curve?

Answer 5

Indicates the minimum amount of money the producer is willing to accepter to offer a good or service

Question 6

What is the producer reservation price?

Answer 6

The minimum amount of money the producer is willing to accepter to offer a good or service

Question 7

What is the short run?

Answer 7

A period of time during which at least one factor of production is fixed

Question 8

What is the long run?

Answer 8

A period of time during which all factors of production are variable

Question 9

How do you calculate profit?

Answer 9

Total revenues - total cost

Total revenues = price x quantity
Total cost = fixed cost + variable cost

Question 10

What is the shut down condition in the short run?

Answer 10

In the short run, the entrepreneur 
should shut down production if the profit/loss from production is less than the fixed cost

If the profit/loss from production is the same as the fixed cost, we assume that the firm will continue to produce 


Question 11

What is the shut down condition in the long run?

Answer 11

In the long run, the entrepreneur should exit the industry if production’s profit/loss < 0.

Question 12

Using a graph, when should a firm shut down in the short run?

Answer 12

If the price line is below the minimum point on the AVC (Average Variable Cost Curve)

Question 13

Using a graph, when should a firm shut down in the long run?

Answer 13

If the price line is below the minimum point on the ATC (average total costs)

Question 14

When is the the supply curve for a firm equal to the Marginal Cost (MC) curve?

Answer 14

o Only for values that are higher than the minimum AVC (in the short run) 

o Only for values that are higher than the minimum ATC (in the long run)

Question 15

Why does the MC curve eventually increase with quantity produced?

Answer 15

The production process is subject to increasing marginal costs
eg. productive losses

Question 16

Where does the MC curve cut the AVC and ATC?

Answer 16

At their minimum points

Question 17

In the long run, why does the the AVC curve become identical to the ATC curve

Answer 17

Because all costs eventually become variable

Question 18

What are the determinants of price elasticity of supply?

Answer 18

• Availability of Raw Material: Large availability = elastic supply and vice versa 

• Factors mobility: the more mobile factors of production are, the higher the elasticity 

• Inventories/excess capacity: the larger amount of inventories, the higher the elasticity 

• Time horizon: Time horizon is the length of time in which a producer has to respond to a change in price. A longer time horizon leads to a higher elasticity because they can search for more efficient inputs and revise production plans